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Pricing: Hourly Rates vs. Fixed Prices

By Erik Reagan

Pricing. It’s one of those things that can sustain or destroy a firm or freelancer. If you get it wrong often enough, you might have to throw in the towel. If you get it right often enough, you can afford to get so many other things wrong—and still survive. (Though that’s not an encouraged model.)

For the past few months I’ve been reading a lot about pricing strategies. In the history of Focus Lab, in addition to my freelance days prior, I’ve seen and used many pricing models. We tried many of them because things just felt wrong. In recent years, though, the pricing changes have been much more strategic and informed. We’re still reading, researching, and learning, but I wanted to share a few observations today.

Hourly Rates

One of the most common approaches to being paid for creative services is to define an hourly rate (or rates) and track time. After a given period of time — a month, a quarter, or perhaps a phase of a project — you send an invoice for your hours. It might look something like this:

I worked 35 hours in March for Client A.

My hourly rate is $100 per hour.

My invoice for March is for $3,500.

It’s pretty simple. You track time, invoice time, and get paid for your time. Other jobs pay employees by the hour, so it makes sense, right?

If you’re really on top of things, you provide an estimate before even starting the work. That might look something like this:

Project A requires 4 tasks.

Task 1 will take me 5 hours.

Task 2 will take me 10 hours.

Task 3 will take me 7 hours.

Task 4 will take me 30 minutes.

Total hours: 22.5

But wait. You’ve worked with clients before. You know you need some time to speak with the client. You need time to review work with the client. And let’s not forget about time spent on emails along the way. Let’s add a little buffer here. Your new estimate looks like this:

Task hours: 22.5

Meeting time: 5 hours (spanning multiple weeks)

Admin/email time: 3 hours (spanning multiple weeks)

New total: 30.5 hours

If we use the hourly rate from earlier, you’re now looking at a $3,050 project. But here’s the thing: this is just your estimate. You know where this is going, don’t you?

The project starts. The client requires far more attention than anticipated. They send you more emails than Nigerian Princes with investment opportunities. What’s more, you completely underestimated Task 1 which actually took you 15 hours. Task 2 took you 12. And Task 3 took you close to 10. (Naturally, Task 4 did actually take you 30 minutes. But that’s not very helpful at this point.)

Your timesheet at the end of the project looks like this:

Task 1: 15 hours

Task 2: 12 hours

Task 3: 10 hours

Task 4: 30 minutes

Email/admin: 7 hours

Meetings: 10 hours

Total time: 54.5

You create an invoice and see that the total is $5,450. That’s not far from double the estimated price. Houston, we have a problem.

This story could go a number of ways but I’ll stop it here. We’ve been in scenarios exactly like what I’ve described. In some cases, our client ended up angry. In most cases, we found a solid solution that everyone thought was fair. Either way, we had to navigate through rough waters.

“If you get [pricing] right often enough, you can afford to get so many other things wrong—and still survive.”

Buckets of Time

An alternate approach is to sell your time in buckets, without hard estimates per task up front. Many agile teams approach pricing this way. You sell a specific number of days/weeks/sprints/etc. and define and estimate tasks later.

The end result is that there are fewer surprises around the actual invoice a client receives. The surprises — or letdowns — in this scenario are more about what a team can or cannot do in a given bucket of time.

For example, you know you have 40 hours of work in a given week. You might set aside 10 of those for yourself and 30 for your clients. If you have a single client looking for enough work at once you may consider selling them your time in buckets of 30 hours, or 1 week, per bucket.

With this approach it’s important to keep your finger on the pulse of the project progress. The assumption with this method is that you don’t know how much time you need at the beginning of a project. As you progress through the work the project likely becomes more clear. You would hate to stay heads down for so long that you get to the last week and realize the next week your income is gone. Regardless of how you price your work, you should watch your project’s progress and your future commitments and availability. But it’s particularly important when you sell your time in buckets.

Fixed Prices

The antithesis of hourly billing is the fixed price. Rather than defining a rate or set of rates, you just come up with a single price for the work at hand.

Let’s say you price the same project above at a fixed rate of $4,000. Even with the same incorrect estimation you end up with a completely different result. You don’t bother the client with the discrepancies. Perhaps you work hard for extra hours to still deliver on time. The client gets the final work and pays the price they expected to pay. My favorite part of a fixed price is that you aren’t limiting your creativity and exploration to hours and minutes. No one likes that.

In this scenario your client was none the wiser and you came away with a valuable lesson. Next time you’ll estimate things better. And you know what? I bet your client might even come back for more work because you delivered on time and on budget.

I love fixed prices. They make for a much better client experience and make cash flow easier to plan and predict in many ways. Plus, the better you get at this the better your profit gets.

Value Pricing

There is another form of Fixed Pricing that gets far more involved. The concept with Value Pricing is that you capture a fair portion of the value you create for your client. Consider the example from earlier. What if your work made your client an additional $300,000 in profit within one year. Do you think your client would be willing to pay more than $3-5k to make that happen?

“Value-based fees are far better for the client because they remove the ethical compromises that attend hourly or daily billing. You want the client to make a single return-on-investment decision at the time of the proposal, not a new ROI decision every day (or hour).”

- Alan Weiss, Value-Based Fees

This blog post is long enough already, so you’ll have to wait until the next post in our Pricing series for that topic.

Resources

I mentioned at the outset that I’ve been reading a lot about pricing. I have my own opinions on the pros and cons of different models, but how about you read up and see what you think for yourself?